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The world has become full of risk-averse investors, and stocks will suffer.
Wait — let’s edit that.
The world has become full of yield preservers, and they will suffer stocks. Or — as is current fashion — stock dividends.
However, there’s something of a temptation to equate dividends to buying stocks outright.
And it would be a dangerous temptation — as the Swiss private wealth managers Lombard Odier pointed out in a recent investor note (emphasis ours):
We hear more and more frequently from clients and investors that the narrowing gap between dividend yields and bond yields (the dividend yield "gap") is a good reason why we should invest in equities. Indeed, dividend yields are now reaching 10 year bond yield levels in the US, and even overtaking them in some other markets. We understand why the desperate search for yield that is taking place today leads investors to consider this as an attractive opportunity.
But the problem, as they note, is that dividend returns are dividend returns; there’s no consequent empirical relationship between dividend yield gaps and forward equity returns, however (emphasis in original):
The middle chart [right, click to enlarge] plots the relationship between the dividend yield gap in the US and the 5-year forward real annualized return of the S&P500. The dispersion of the cloud of dots could not be more telling: a higher dividend yield gap is not associated with higher forward absolute (or relative) returns. Looking at 1 and 10-years forward returns gives exactly the same conclusion. Moreover, we get the same result when we look at European markets: buying equities when the dividend yield gap is positive is not a systematically more profitable strategy than buying equities when the dividend yield gap is negative!
Investors are forgetting the other components of equity valuation, then – earnings per share, EV/EBITDA, and so on – as interest in equities comes back under pressure to find yield. And investors will come crawling back.
There’s thus a better recourse if it must be dividend returns, according to Lombard Odier (emphasis ours):
Stripping out the dividend part of the stocks by hedging out the beta with options or other structured products is probably an interesting strategy to consider. However, it is vital to buy nothing more than what is cheap today "“ namely dividends – and not hastily draw the conclusion that the dividend yield gap is a measure of equity valuation…
And it’s interesting to note that many of the most eye-catching dividend plays are indeed stripped-out structured strategies — James Montier’s dividend swaps, or Morgan Stanley’s dividend futures, for example. Fair enough.
Just watch out for the mispricings. Update – more in the usual place.
Related links: What are stock index future curves telling us? – FT Alphaville The Cult of Equity is dead. Long live bonds – FT Alphaville We are all widows and orphans now – Reuters
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